For Cuba, further US airline capacity cuts are likely, as USA trade relations cool

Analysis

On the grounds that the thawing of relations between USA and Cuba introduced by the previous US government was enriching the Cuban military and the intelligence services that contribute so much to oppression on the island, US President Donald Trump has reversed the legislation that had begun to open the Caribbean island to arrivals from the USA.

The decision of the Barack Obama administration to thaw relations between USA and Cuba was seen as a landmark ruling opening the island up to 110 daily commercial flights from the US. But despite the strong interest from US airlines for the traffic rights, particularly into Havana, the anticipated demand has not materialised and five airlines have already suspended or cut routes into Cuba citing high costs and weak bookings.

Despite this, traffic levels between the two countries over the first six months of 2017 have grown to record levels, putting a strain on the country's ageing tourist infrastructure.

President Trump has taken a more confrontational approach; four key objectives

President Trump has now taken a clearly more confrontational stance in terms of diplomatic relations with Cuba. “I am cancelling the last administration's completely one-sided deal with Cuba," he said in a speech that outlined his plans last week. He said the Obama administration had simply made a deal “with a government that spread violence and instability in the region,” and added: "We now hold the cards. The previous administration's easing of restrictions of travel and trade does not help the Cuban people. They only enrich the Cuban regime."

The new outlook on USA-Cuba relations means an immediate tightening of policy between the two nations and the prohibition of financial transactions between Americans and Cuban companies affiliated with the country’s military or intelligence services. It also introduces restrictions on individuals being able to plan their own educational trips to the island outside of tour groups and boundaries as to where they can spend their money.

The US Department of State says the policy amendments are based around delivering four key objectives:

to enhance compliance with US law - in particular the provisions that govern the embargo of Cuba and the ban on tourism;

hold the Cuban regime accountable for oppression and human rights abuses ignored under the Obama policy;

further the national security and foreign policy interests of the United States and those of the Cuban people; and

lay the groundwork for empowering the Cuban people to develop greater economic and political liberty.

The then US transportation secretary Anthony Foxx, assistant secretary of state for economic and business affairs Charles Rivkin, Cuban minister of transportation Adel Yzquierdo Rodriguez and president of the Cuban Civil Aviation Institute (IACC), Ministry of Transportation Colonel Alfredo Cordero Puig signed a memorandum of understanding in February 2016 to launch up to 110 daily commercial passenger flights between the US and Cuba. This included links to Havana and nine other destinations in the communist island in February 2016, restoring regular air travel for the first time in more than 50 years.

A precursor to this landmark agreement was reached the previous year when the historic deal was agreed in principle. US travel to Cuba had risen by more than 50% in 2015 and there has been an even greater rise in travel from other countries, since former President Obama and Cuban President Raul Castro announced the historic detente in late 2014.

The MoU allowed airlines of each country to operate up to 20 daily scheduled frequencies between the US and Havana and up to ten daily frequencies to any other airport in the country (Camaguey, Cayo Coco, Cayo Largo, Cienfuegos, Holguin, Manzanillo, Matanzas, Santa Clara and Santiago de Cuba) and instigated one of the most heavily oversubscribed request for air services from US airlines ever.

These flights were in addition to the historic limited charter programmes that had been serving the countries while hefty sanctions had been in place. The former US secretary of state, John Kerry said the new agreement would facilitate growth in authorised travel between the countries. “In the past, US-Cuba dialogue was narrow, relatively sterile, and rare. Over the past year, it has been comprehensive, business like, and routine,” he said when the agreement was first reached in 2015.

Although tourist travel from the US to Cuba remained banned, the agreement facilitates travel that falls into twelve certain categories. These include family visits, trips related to journalism, government business and public performances.

US airlines anticipated enormous potential demand

The reaction from the US airline industry to the Cuban opportunity highlighted the massive potential on offer from a market that had been closed to scheduled traffic for more than half a century. Cuba boasted something unique and new for the international tourism market and scheduled flights took off for the first time at the end of August 2016 when JetBlue inaugurated the first of its new services between the countries.

The US is now the largest international source market in terms of capacity into Cuba ahead of Canada, Mexico and Panama. France, Spain, Germany, UK, Netherlands and Italy provide strong connectivity from Europe as Cuba remains a popular and increasingly better connected long-haul destination for European visitors.

Largest international markets from Cuba by capacity (w/c June 19, 2017)

Source: CAPA – Centre for Aviation and OAG

The introduction of regular flights between USA and Cuba will help to boost international capacity above the ten million seat milestone in calendar year 2017, based on current published schedules from OAG, with the total supply more than doubling over the past five years.

Annual scheduled international seats in Cuba (2012 – 2017)

Source: CAPA – Centre for Aviation and OAG

Initial interest failed to translate into sustainable demand for some airlines

Despite the optimism and massive interest from the US carriers to the potential for Cuba, the delivery of multiple daily scheduled frequencies into Cuba from the US has not delivered the traffic some airlines predicted. The slide in demand has led a number of airlines to reduce or completely eliminate flights to the country, including regional carrier Silver Airways and ultra low cost carriers Frontier Airlines and Spirit Airlines.

In fact schedules data from OAG shows that air capacity between USA and Cuba will be 18.8% lower in the second half of 2017 than during the first six months - falling from 58,389 return seats in 1H to 47,425 in 2H.

The data shows average daily capacity falling from over 10,000 seats across Q1 2017 to less than 8,000 during the forthcoming Q3 and Q4 periods. This month’s data shows that American Airlines has the largest share of capacity between the nations (34.2%) ahead of Southwest Airlines (23.8%), JetBlue Airways (21.3%), Delta Air Lines (10.6%), United Airlines (4.7%) and Alaska Airlines (4.5%).

Silver Airways had actually served the most points in Cuba, albeit its presence was limited by the operation of smaller 30- to 36-seat Saab 340 turboprops. The airline had flights from Fort Lauderdale to eight Cuban destinations (Santa Clara, Camagüey, Cienfuegos, Holguín, Santiago, Cayo Coco, Varadero and Manzanillo) served on a twice and three times weekly schedule and was due to add services to Cayo Largo in 2017. However, it closed its network over a four week period between mid-March and mid-April citing high costs of operation.

Spirit Airlines ended its Fort Lauderdale-Havana route from May 31, 2017 after just six months of operation. Its president and chief executive officer, Bob Fornaro said the airline worked hard to make the route work, “but the costs of serving Havana… outweigh the demand” for the service. “Due to overcapacity and the additional costs associated with flying to Cuba, we don’t find it sustainable to continue this service while maintaining our commitment to pass along ultra-low fares to our customers,” he added.

Meanwhile, Frontier Airlines ended its flights between Miami and Havana from June 4, 2017, citing overcapacity in the market, as well as operating costs exceeding its initial assumptions.

American Airlines was first to cut back on capacity

American Airlines was actually the first to reduce its service to Cuba, announcing in November 2016 that it would cut flights from Miami to Holguín, Santa Clara and Varadero from two daily to one. JetBlue Airways has also introduced smaller planes on several routes, including from Fort Lauderdale, to Havana, Santa Clara, Holguín and Camagüey.

The high cost of operating to Cuba and in particular the landing fees in the Caribbean nation were always going to be a major hurdle for airlines. But it appears that many may have been blinded by the urgency to be part of the Cuba revolution and with no real data to deliver demand assumptions, may have been a little eager to gain traffic rights and slots ahead of competitors. It appears, in this instance, that any long term ambitions may have been blocked by the cost hurdle.

It is clear that after the explosion of excitement about travel to Cuba after the country opened its borders to the US in 2016 for the first time in decades, Americans are less interested in travel to Cuba this year.

A recent survey from insurance provider Allianz Global Assistance found three quarters of respondents said they were not likely to plan a trip to Cuba in 2017 with only 2% planning to visit Cuba in the next six months or by the end of 2017. It also found that 60% of Americans said they “would not like to travel to Cuba” compared to just 58% in 2016.

Tighter restrictions will further impact outbound tourism in the short term

The new rules include a prohibition of financial transactions between Americans and Cuban companies affiliated with the country’s military or intelligence services. This will likely have a significant impact on US travel to Cuba due to the dominant role of the state-run, military-affiliated Grupo de Administración Empresarial SA (GAESA) conglomerate in the Cuban economy.

The new policy aims to channel economic activities away from GAESA, including most travel related transactions, while allowing American individuals and entities to develop economic ties to the private, small business sector in Cuba. This is not an easy practice considering that the conglomerate owns almost all of the retail chains in Cuba and many of the mainly foreign run hotels on the island.

The Trump approach makes clear that the primary obstacle to the Cuban people’s prosperity and economic freedom is the Cuban military’s practice of controlling virtually every profitable sector of the economy. President Trump’s policy changes will encourage American commerce with free Cuban businesses and intends to put pressure on the Cuban government to allow the Cuban people to expand the private sector.

There are also measures to ensure that the statutory ban on tourism is strictly enforced. Among other changes, travel for non-academic educational purposes will be limited to group travel. The self-directed, individual travel permitted by the Obama administration will be prohibited. However, Cuban Americans will be able to continue to visit their families in Cuba and send them remittances.

“Our policy will seek a much better deal for the Cuban people and for the US. We do not want US dollars to prop up a military monopoly that exploits and abuses the citizens of Cuba,” said President Trump. “We will very strongly restrict American dollars flowing to the military, security and intelligence services that are the core of Castro regime. They will be restricted. We will enforce the ban on tourism. We will enforce the embargo.”

Limited tourist infrastructure, high costs and one direction demand remain hurdles to connectivity

Market demand will ultimately determine whether scheduled flights continue in their current form or whether there will be a transition back to charter flights. The treasury and commerce departments of the US government will release precise regulations within 30 days. The revised policy will allow cruises and airlines to continue normal activity, but could dampen hotel development plans.

United Airlines and Alaska Airlines said in statements that they are assessing policy changes to see what affect it could have on passengers, while Delta Air Lines, JetBlue Airways and American Airlines said they will adhere to new changes and will continue to fly their regular flights to Cuba.

Peter Cerdá, IATA’s regional vice president for the Americas acknowledged at the recent IATA AGM in Cancun, Mexico that initial scheduled air passenger traffic from the US to Cuba “has been lower than expected,” but that the country “continues to present an opportunity in the near and long term”. He added that a “huge hunger” from the US airline sector delivered “a clear overcapacity into Cuba”.

IATA remains “actively engaged” in its plans to launch a Billing and Settlement Plan (BSP) within 2017 and “provide assistance and expertise regarding the improvement of airport and airspace infrastructure” to be able to accommodate future growth with Mr Cerdá suggesting the reduction in capacity from airlines cutting frequencies and pulling flights will “balance out the playing field”.

Concerns over its limited infrastructure have been an underlying issue since the Obama administration first announced its intent to open the doors to trade with Cuba. The Allianz Global Assistance survey also highlighted the lack of travel infrastructure as a major cause of anxiety about traveling to Cuba for Americans with concerns of food shortages, disappointment over limited working internet, lower hotel standards, and lack of running water among the issues.

Interestingly, President Trump’s policy changes make no mention of port or airport fees forming any part of its clampdown on funds being filtered through to GAESA and this will ultimately safeguard international accessibility between the US and Cuba. While the costs may continue to influence air demand, the cruise industry is likely to grow its share of arrivals as it effectively brings its own infrastructure to the island with its passengers.

IATA’s Peter Cerdá said José Martí International Airport in Havana has to enhance its infrastructure as a matter of urgency to support growing demand into the Cuban city. Alongside new flights from the US, enhanced connectivity from Europe and Latin America means “they need to build up the infrastructure quite quickly,” he said. “It’s a major issue,” he added.

The airline body continues to work to deliver a BSP for Cuba to allow accredited local travel agents to sell outbound tickets and balance the directional variation in demand. Currently tickets in Cuba are only sold directly by airlines either from city or airport offices, but IATA is working to “set up a financial system mechanism for travel agents and airlines” as a facilitator for growth in outbound ticket sales.

Cuba remains a high potential destination – for the longer term

What is clear is that Cuba still has a lot to offer foreign travellers, including those from the US, but airlines may need to take a slightly longer term outlook before they can offer a sustainable network of services into the island.

After all they have already waited more than 50 years to serve the market on a scheduled basis.

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